This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, click the "Reprints" link at the bottom of any article.

March 11, 2013

Measuring Risk in Target-Date Funds

At 401(k) Summit, panel debates benchmarking TDFs

You can’t talk about 401(k)s for three days without eventually coming around to target-date funds. They’re offered in 70% of defined contribution plans and are expected to account for 70% of all assets in DC plans by 2020, according to speakers at a session during the 2013 NAPA/ASPPA 401(k) Summit.

TDFs’ “explosive growth masks the fact that they are still in their infancy,” Rich Weiss, senior vice president and senior portfolio manager of American Century Investments, told attendees on March 4. “Most funds were launched in the last five or 10 years, but there’s a dearth of real-time data.” With no industry-accepted standard benchmark, many providers produce their own, he said.

Typical measures of a TDF are to examine the equity allocations at retirement or count the number of asset classes in the fund, but Weiss said these were best undertaken by an independent third party. A more sophisticated measure is to look at the underlying portfolios using both historical and forecasted performance data, he suggested. When evaluating the overall risk of the series, advisors should incorporate the entire lifespan of the fund, he said.

One of the challenges, Weiss said, is that you need a lot of data for a successful risk measurement to be accepted.

To define a target-date objective, according to Jerome Clark, portfolio manager at T. Rowe Price, requires a participant’s retirement readiness, expectations and risk priorities. There are three types of risk, he continued: market risk, longevity risk and inflation risk.

Clark noted that the to-versus-through aspect of target-date funds can be confusing to participants and urged advisors to push toward an objective, rather than a date.

John Miller, head of U.S. retirement for PIMCO, noted that target-date fund evaluation was moving from an analysis of performance versus costs to the level of risk relative to the objective. Among the risks to watch out for is a glide path that is riskier than the participant is prepared to tolerate. Furthermore, a fund’s diversification may be riskier than it initially appears. Advisors should look at the underlying funds to determine how many asset classes are represented and what the risk drivers are. Finally, multiple economic scenarios can present different levels of risk, he said.

The primary goal, Miller said, is to provide a sufficient rate of return to reach success while minimizing risk.

An attendee asked the panel how target-date funds can be used when assumptions don’t take into account participants’ behavior.

TDFs “operate in a narrow band of assumptions,” Weiss said. "The major drivers of success are how much you saved for retirement and how long you’ll live, which is unknowable.” With that in mind, you have to “operate in reasonable scenarios,” he said, pointing out that if a participant is a bad saver, it doesn’t matter which TDF he selects.

Clark added that while a significant number of participants roll their assets into an IRA when they leave the plan, not everyone does. “If they’re not taking a rollover, we can’t help them,” he said. “Why design a product for bad behavior?” Clark added that plan sponsors can make changes to “help participants get to retirement in a better fashion by creating a good glidepath for the people they can help.”

Miller stressed that if participants aren’t saving much, they have to protect what they do have by minimizing risk. “A key concern,” he said, “is what happens if things aren’t normal? Can the glidepath withstand market shocks?” Market regimes can last 10 to 30 years, he added.

Sign up now—it's Free!

Sponsor Showcase

ThinkAdvisor's TechCenter is an educational resource designed to give you a competitive edge by keeping you abreast of new tech innovations and need-to-know information that can be applied to your business.